Beginner’s Guide to Angel Investing

Have some extra cash and want to start investing in startups? Become an Angel Investor. An Angel Investor is a private investor who provides working capital for business startups in exchange for equity. Angel investing is a risky investment but the reward is great if you pick winners. Because the majority of startups fail, due diligence is key. Here are the factors to consider when evaluating startup investment opportunities.

Founders

Great founders can make the difference between startup success and failure. You are betting on the founder as much as the company.

Character

Look for founders that are driven by passion and are able to make the tough decisions when needed. They must view the company as a business and not a hobby. That means seeking profitability and growing the business responsibly. Look at how they manage relationships. This can show what kind of manager and business partner they will be. Founders should be calm under pressure since there are few things as stressful as launching and running a startup venture.

Track Record

Get to know the background and track record of founders. Do they have experience in the sector they are launching in? Are they serial entrepreneurs? If so, look at how they ran previous ventures. Serial entrepreneurs often are able to take a more disciplined approach towards future startup ventures. Whether they succeeded or failed in the past is not as important as how they handled success or failure. You want to be sure the founders will make responsible decisions with your money.

Location

Where a founder chooses to start a business is an important factor to consider. Be aware that companies coming out of Silicon Valley may be overvalued because of their proximity to all that VC money on Sandhill Road. However, that close access to capital also attracts talent for hiring, while at the same time driving up the price for that talent. Ask if the locational advantage exceeds the extra cost of talent and space. Companies that are outside of main hubs like San Francisco and New York are often undervalued and can present a good opportunity for return. With the emergence of remote work, companies can find success outside of main hubs.

Market Opportunity

As an angel investor, you must become familiar with the market that prospective investments are launching in. It’s advisable to choose a sector in which you have some previous background and specialize in that area.

Market Size

Look at the market size to determine what percentage of the market the company needs to attract to reach profitability. Sometimes larger markets are already saturated so the opportunity may be small unless they can disrupt the space in a big way (see Dollar Shave Club). With niche markets, if the company dominates the market, they may be able to generate more money than if they were launching as a small fish in a large market.

Opportunity

Look for holes in the current market. For example, the social media market is saturated and dominated by players like Facebook and Twitter. Snapchat was late to the game but was able to rise to fame by creating a product that did something different than all the others, disappearing pictures, and gaining traction with a young audience. Now they are able to compete with major players.

Competitors

A founder should be aware of the competitors in the space. In order to be successful, the new company must do something slightly different than others in the sector. This can be in the development of the product or the marketing. Look at Uber and Lyft. They do basically the same thing, but the marketing is substantially different. How is the company positioned compared to competitors?

Product Traction

Before conducting a seed round, many startups will have completed initial user testing to validate the product. This can provide insight for investors as to the user reception and market opportunity.

 User Count

Part one of the traction puzzle and likely the most deceptive. How many users are on the platform? The crucial and often overlooked part of user count is user engagement. How many of those users are using the platform regularly, or at least more than once? Be aware that a large user count does not necessarily equal success.

User Growth

How quickly are user numbers growing? Are there any signs of decline? You are looking for consistent upward growth. In the seed stages, growth may be on a very small scale. Is “word of mouth” marketing leading to growth in the user count? If current users are spreading the word, that is a good sign for future growth fueled by marketing dollars.

Platform Stickiness

This is part of user engagement. How long are users spending on the platform? Often as companies grow, engagement time decreases with new users. Social media platforms like Facebook have been very successful with continued user growth paired with growth in time on the platform. The average user spends 50 minutes on Facebook!

Churn Rate

Churn rate is the percentage at which customers stop utilizing the platform. Look for companies with little to no churn rate. Companies with high churn rate should be able to explain why customers are churning and what the company is doing to increase user engagement.

Marketing Strategy

In the cutthroat startup world, a strong marketing strategy is vital. There are two types of marketing in startup land: paid and unpaid. Often early-stage startups are looking to raise money for paid marketing. It’s important to look at their previous unpaid strategy as this can give you insight into how well their paid marketing strategy will perform.

Customer Acquisition Cost

Customer Acquisition Cost or CAC is calculated by dividing the cost of marketing expenses by the number of customers acquired in a given time period. If a company is looking for funding for marketing, make sure they have a projection of the CAC. Another big metric to look at is Lifetime Value or LTV. This is how much each customer is worth over the lifetime of them using your product. If you can acquire a customer for $10 and that customer will spend $100 over their lifetime, the economics of their acquisition strategy are favorable for scalable growth.

Referral Rate

“Word of mouth” marketing is often the first tactic utilized by startups to acquire customers. Look for a strong referral rate from current customers. Many startups have begun to incentivize user referrals by offering perks in exchange for a referral.

Unpaid vs Paid

Companies should have a plan for both unpaid and paid marketing strategy. Unpaid strategies often employ current customers and include public relations, brand ambassador programs, search engine optimization (SEO) and referral programs. Paid strategies include ad campaigns, brand development and content marketing. Usually paid strategies can help to scale the business to the masses. Ideally, startups should have a unpaid and paid marketing strategy conducted in tandem.

Revenue

For many years, startups that were pre-revenue were buzzed about. The tide has turned and now investors are looking for viable revenue streams when investing. Look for companies that have a plan on how to become profitable.

Revenue Streams

Determine the different options available for revenue creation. This can range from subscription services to premium add ons to ad revenue. The freemium model is popular in the consumer SaaS space. With this type of revenue stream, the company needs to determine how to supplement revenue without subscription income.

Time to Profitability

This is where the financial models come into play. It’s impossible to determine exactly when a company will become profitable but it’s crucial investors identify a tentative timeline to profitability.

Customer Lifetime Value

Customer Lifetime Value or CLV is a prediction of value contributed to a company by a customer over their entire relationship with the company. This number is easy to determine with subscriptions services. In non-subscription services like Facebook, this marker would be used to determine how much the customer contributes to Facebook’s growth in ad buys and data profitability.

Investors

As a newbie to startup investing, it’s important to look at the other investors involved in the deal. Often, this can be a sign of startup health.

Sector Specialists

If you aren’t an expert in the sector you are investing in, look for investors that are. If an expert in social media invests in a new social media venture, they likely have good reason for doing so.

VC Firms

If you have the opportunity to invest in deals alongside major Venture Capital players, this can be very helpful. Big VC firms have teams to conduct due diligence on potential new investors. Think of it as free pre-screening for you. On the Crowdfunder platform, angels are always investing alongside major VC firms.

Conclusion

Startups are a risky investment but if you conduct the proper due diligence you are more likely to find success. You won’t make money overnight. Expect at least a 3-5 year investment horizon if the startup succeeds. Don’t put all your eggs in one basket. Diversify your investments and invest in more than one company if possible (or check out our VC Index Fund for another diversification option). Ready to get started? We’re always here to help.

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